Will Detroit's latest attempt to shed a part of a 2005 debt deal that went sour be successful in court? / Carlos Osorio/AP Photo

Written by

the Detroit Free Press Editorial Board

Thatís surely what Detroit emergency manager Kevyn Orr is hoping, as the third attempt to pay off a pernicious city debt wends its way to U.S. Bankruptcy Judge Steven Rhodes.

Orrís been lobbing money at UBS and Bank of America Merrill Lynch, the counterparties to the cityís infamous credit swaps, since late last year, even before the city was deemed eligible for municipal bankruptcy. Rhodes rejected Orrís first two attempts to settle the debt, saying the deals were too expensive for the city and too lucrative for the cityís creditors, signaling that a legal challenge to the legitimacy of the transaction itself could be successful.

In the cityís array of debt and liabilities, the swaps deal is one of the hardest to understand. In 2005, the City of Detroit, in chronic arrears to its two retirement funds, sold about $1.4 billion in debt, called pension obligation certificates, that allowed the city to wipe out what it owed its pensions funds. Then the city entered into a credit swap deal intended to lock in a favorable interest rate. The deal turned bad when interest rates fell below the rate the city negotiated; payments now consume about 5% of the cityís annual revenue.

The offer currently on the table would settle the swaps at $85 million on a $286-million debt, about 30 cents on the dollar. Under the plan of adjustment proposed by Orr, unsecured general obligation bondholders would receive about 20 cents.

The Free Press Editorial Board supported each of the two previous deals, and both times our logic was the same: If the city successfully challenged the legitimacy of the swaps deal, or won a decisive ruling that the swaps were unsecured, it could do better. But reaching either of those outcomes would take time and money ó both commodities that the city lacks.

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Rhodes thought the city could do better, and thatís the kind of leverage that a bankruptcy judge can apply.

So we were wrong. Rhodesí persistence has resulted in a much larger write-down than Orr initially achieved.

Once again, settling this debt isnít about the best deal. Itís about the best deal that the city can get. Could Detroit fight its way to 20 cents on the dollar, or to a legal verdict wiping out the swaps entirely? Itís possible. But reaching those outcomes could take years, and absorb millions in legal fees.

Settling the swaps now frees city cash to settle debts and for investment in operations. Thatís why we supported the earlier deals. But thereís another aspect: Creditor acceptance of this payoff would also give Rhodes the ability to force a settlement (called a cram-down) on creditors in other parts of Orrís restructuring plan who might be less compliant.

Thereís no certainty that Rhodes will approve this deal. After all, he shot down two previous deals that would have settled the debt for $230 million and $165 million. At this point, one thingís clear: If Rhodes thinks that settling the swaps at $85 million doesnít make sense, he wonít sign off. And if he does, well, we should all agree that the city couldnít have done better.

The last time Rhodes was asked to approve a deal to settle the swaps, he allowed the city to sell debt ó previously included in the swaps settlement ó to invest in operational restructuring.

Which brings us back to the deal that started all of this, the pension obligation certificates sold in 2005. Look at Detroitís troubled financial history, and one thing comes through loud and clear: Some of the cityís biggest disasters, like the pension obligation certificates, seemed like good ideas at the time. Or, if not good, necessary. The only way to stop the bleeding is to restructure and fend off financial doom.

Well, financial doom arrived last summer, in the form of Detroitís municipal bankruptcy, which formalized what Detroiters already knew: The city is broke, unable to perform the most basic functions of municipal government with ease or regularity, and burdened by so much debt that it has little left to cut and almost nothing with which to improve residentsí quality of life.

So itís not enough to straighten up the cityís books, as Orr and his team are working to do. Detroit needs a more functional, modern, effective city government, and the investment Orr is working to finance is a key to that. Some critics of the deal are rightly wary of an infusion of cash into a broken city, worried that this will add to the pile of debt without making a dent in services or restructuring.

That canít happen, and itís up to Orr, Rhodes, Mayor Mike Duggan and the Detroit City Council to make sure it doesnít.